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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

AJ Bell’s Tom Selby explains the rules around ‘uncrystallised funds pension lump sums’
Thursday 01 Jul 2021 Author: Tom Selby

I’ve just taken a £20,000 UFPLS from my pension. I have no other taxable income, so expected a quarter of it (£5,000) to be tax free and the rest subject to a few hundred quid of tax. Yet, HMRC has taken several thousand pounds. Is this right?


Tom Selby AJ Bell Senior Analyst says:

UFPLS stands for uncrystallised funds pension lump sum and is one of three primary ways of taking a retirement income from a defined contribution pension, alongside an annuity or entering drawdown.

A UFPLS is an ad-hoc lump sum taken directly from your pension pot, with 25% of each lump sum tax-free and the rest taxed as income.

Therefore, someone who has no other taxable income and takes a £20,000 UFPLS might expect the first £5,000 to be tax-free, with the remaining £15,000 taxed as income.

Based on 2021/22 income tax rates the first £12,570 should fall within the personal allowance, with the remaining £2,430 taxed at 20%. So, in theory, you might expect your total tax bill to be around £486.

This won’t be how it plays out if it is your first taxable pension withdrawal of the tax year. Instead, HMRC will have required your pension provider to apply the emergency tax code on a ‘Month 1’ basis. Your usual allowances will be divided by 12 and applied to the taxable part of your withdrawal.

Note the tax-free portion of your withdrawal should always be tax-free (provided you have sufficient lifetime allowance available).

Let’s take the example of someone who has taken a £20,000 ad-hoc lump sum from their pension. The first £5,000 is tax-free, with the rest subject to income tax. If a Month 1 tax code is applied to the rest of the remaining £15,000 withdrawal, the personal allowance is £1,047.50 (£12,570 divided by 12).

The portion taxed at 20% will then be £3,141.67 (the £37,700 basic-rate tax band divided by 12), generating a bill of £628.33.

The portion taxed at 40% will be £9,358.33 (the £112,300 higher-rate tax band divided by 12), resulting in a £3,743.33 bill.

Finally, the remaining £1,452.50 of the withdrawal will be taxed at 45%, generating a bill of £653.63.

That means a total tax bill on the £20,000 withdrawal of £5,025.29 – over 10 times what you might have expected to pay.

This issue tends to only affect the first flexible withdrawal you make in a tax year, either by drawdown or UFPLS.

If you take a regular income, then HMRC should sort out your tax position automatically via your tax code. If you only make one withdrawal then you will need to fill out one of three forms to get a refund, which HMRC says should be processed within 30 days:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z

• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z

• If you’ve only flexibly accessed part of your pension pot then use form P55

If you are happy to wait HMRC will correct your tax position at the end of the tax year.

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